Woodward Inc (WWD) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward Governor Company first quarter fiscal 2011 earnings call. At this time, I would like to inform you that the call is being recorded for your rebroadcast and that all participants are in a listen-only mode. Following the presentation, you will be invited to participate in a question and answer session.

Joining us today from the Company are Mr. Tom Gendron, Chairman and Chief Executive Officer, and Mr. Bob Weber, Chief Financial Officer and Treasurer. I would now like to turn the conference over to Mr. Weber. Sir, you may begin.

Thank you, operator.

We would like to welcome all of you to Woodward's first quarter fiscal 2011 conference call. In a few minutes, I'll cover the financial highlights of our first quarter and Tom will comment on our results, strategies, and markets. I will then comment on today's earnings release, and at the end of our presentation, we will take questions.

For those who have not seen the release, you can find it on our website at woodward.com. As noted in the press release, we have included some visual presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available through January 28, 2011. The phone number for the audio replay is on the press release announcing this call and will be repeated by the operator at the end of the call. In addition, a replay of this call will be accessible on our website for 14 days.

Before we begin, I would like to provide our cautionary statement as shown on slide three.In the course of this call, when we present information and answer questions, any statements we make other than factual results or business facts may contain forward-looking statements. Such statements involve risks and uncertainties, and actual results may differ materially from those we currently anticipate.

Factors that might cause a material difference include, but are not limited to, future sales, earnings, business performance, and economic conditions that would impact demand in the Aerospace and Defense, Power Generation and Distribution, and Transportation markets. We caution investors not to place undue reliance on these forward-looking statements, as predictive of future results.

In addition, the Company disclaims any obligation to update the forward-looking statements made herein. For more information on risks and uncertainties facing Woodward, we encourage you to consult the press release and our public filings with the Securities and Exchange Commission, including our 10-K for fiscal 2010 and 10-Q for the quarter ended December 31, 2010, which we expect to file shortly.

Going forward, as we refer to net earnings on these calls, we are technically speaking to net earnings attributable to Woodward. In addition, segment earnings, EBIT, EBITDA, and free cash flow are non-US GAAP operating measures that we use in the press release and during this call. A description of these measures and a reconciliation of each to the most comparable US GAAP measure is included in the appendix to our slide presentation and in our earnings release and related schedules, all of which are posted on our website. Management uses this information in monitoring and evaluating the ongoing operating performance of Woodward and each business segment.

I would like to now switch to our quarterly financial highlights. Our first quarter reflected growing evidence of improving markets. Sales for the first quarter were $365 million, up 8% from $339 million in the first quarter of last year. Reported earnings per diluted share were $0.32 for the first quarter of 2011 and $0.32 for the first quarter of last year.

Earnings for this year's first quarter reflect good overall operating leverage, offset by a charge related to a change in the estimate of future workmen's compensation costs, as well as negative Airframe Systems performance. I will discuss these more fully later.

Free cash flow for the quarter was a negative $3 million, reflecting increased investments in working capital as sales growth returns. Our debt leverage ratio continued to decline slightly to 1.7 times EBITDA. Overall, these results indicate that our business has continued to be in a recovery phase, but quarterly variability is evident, and our balance sheet remains strong.

Now, I will turn the call over to Tom to comment on our results, strategies, and markets.

Thank you, Bob, and welcome to those joining us today.

Recovery in our markets continue with very few exceptions, and we remain focused on leveraging the anticipated sales growth through supply chain management and the pursuit of growth opportunities. Our Turbine, Electrical Power, and Engine Systems segments reported good revenue growth this quarter. These businesses are experiencing solid recoveries, as well as market share gains. We believe that the worst of the cycle is now behind our Airframe Systems business and it should experience better revenue and profitability in coming quarters, as its markets and operational leverage and performance improve.

Turning to our markets, the Commercial Aerospace Market continues to show signs of improvement. Commercial passenger and cargo air traffic continue to improve, now exceeding pre-recession levels, and demand for our after market products and services in both our Turbine and Airframe business segments is reflecting this. Business Aviation Utilization is improving and after market opportunities there are starting to develop.

Commercial Aircraft production rates are increasing, with further increases scheduled over the next several years. The 787 and 747-8 continue their certification testing and are expected to enter service during our fourth fiscal quarter. The recently announced delay has been considered in our 2011 outlook. As you may recall, the 747-8 offers the GEnx engine exclusively. The GEnx is one of two engines offered on 787. Woodward has been shipping low volumes of GEnx fuel systems. We are prepared to ramp up with increased production of these aircraft.

Regional Jet production is mixed, with selected platforms doing well. The recently launched Russian Regional Jet is one positive example, which will drive demand for our Airframe Systems cockpit controls. While demand for larger business jets remains solid, small business jet production rates remain under pressure.

Rotorcraft have remained fairly steady and now show signs of improving volumes, in particular, the Bell 429, in which we have substantial actuation content, is ramping up production.

An important piece of Aerospace news came out this past quarter, when Airbus announced its intention to offer two new engines on its A-320 aircraft. We continue to aggressively pursue these opportunities and expect supplier selections to occur over the next two quarters.

Defense spending in our markets remains steady, with foreign military sales offsetting some softness in US government spending. Within the Defense market, spending remains solid for platforms which we support, such as rotorcraft, fighter jets, tactical weapons, and UAVs.

Turning to Industrial Turbine, we continue to see recovery in Industrial Turbine build rates. In particular, we believe the increasing availability of natural gas, the relative ease of permitting and setup, as well as the lower emissions of these turbines, should drive up their share of the global Power Generation market and lead to significant long-term growth, and we have continued to increase our content and market share in these turbines.

Turning to Wind, we continue to expect significant growth, approaching 30% in wind converter sales this year, largely due to increasing market share, as mentioned in previous press releases, even though some wind turbine producers have taken down their anticipated build rates. Our modular inverter design continues to be well received in the marketplace, along with the quality of our product support and the flexibility that comes with our global operations.

Looking at our Grid-related Product portfolio, our Power Distribution and Protection Control products are experiencing good growth, largely in emerging markets. We remain optimistic about the long-term global growth potential for electrical power, resulting from increasing power demand and the onset of smart grid technology. This business also leverages our global footprint and strong relationships with successful OEM customers.

Demand for industrial reciprocating engines and our clean engine technologies has continued to improve dramatically from lows seen in 2009 and early 2010. The increased demand now extends across our portfolio of Small and Large Engine Solutions. Demand related to global projects for power generation, mining, and fossil fuel extraction processing and distribution have all helped to drive our results, and should continue to be solid through 2011.

In summary, nearly all of our markets are improving, either in sales or order volumes. Through strength in R&D investment and driving technological leadership, we continue to expand our market share across our business segments. We believe this path will drive sustainable growth as recovery progresses.

Now, let me turn it back to Bob for the financials.

Thank you, Tom.

At the Woodward consolidated level, net sales this quarter were $365 million compared to $339 million for the 2010 first quarter. Three of our four business segments saw improvement in the top line this quarter, versus the first quarter of 2010. 2011 is shaping up to be a typical year for Woodward, with sales lighter in the first quarter, and accelerating through the balance of the year.

Net earnings for the first quarters of both 2011 and 2010 were $22 million, or $0.32 per share. This year's first quarter results included a $3.6 million pre-tax charge, or $0.03 in earnings per share related to a change in the estimate of future workmen's compensation costs. $2.2 million of this charge impacted Airframe Systems.

EBIT, or earnings before interest and taxes, was $38 million for this quarter compared to $40 million for the prior year's quarter. EBIT was favorably impacted by the sales volume increases, but was more than offset by a reduction in customer funding at Airframe Systems and the impact of the workmen's compensation charge, as well as research and development costs, which increased by $5.4 million, related to anticipated growth in most of our markets. Variable compensation expense increased by $1 million, reflecting the improved results we anticipate for the full year.

Free cash flow for the first quarter was a negative $3 million, compared to a positive $52 million for the prior year's first quarter. The reduction in operating cash flow was primarily related to investments in working capital, anticipating the upturn in our markets.

Turning to our business segments, Turbine Systems segment net sales for the first quarter of fiscal 2011, which include inner segment sales, were $154 million compared to $142 million for the first quarter a year ago. Sales increased in both Aerospace and Industrial Platforms.

In Aerospace, our Turbine after market growth out paced OEM growth. Segment earnings for the first quarter of 2011 increased to $36 million from $32 million for the same quarter a year ago. As a percent of sales, segment earnings were 23.7% this quarter, compared to 22.5% in the same quarter a year ago. Our segment earnings benefited from the increased volumes and strong after market sales, partially offset by increased research and development costs.

Moving to our Airframe Systems results. Airframe Systems net sales for the first quarter of fiscal 2011, which include inner segment sales, were $84 million compared to $92 million in the first quarter a year ago. Sales levels reflected a decline in customer-funded development and quarterly variability in the delivery of weapons systems, partially offset by an uptick in commercial volumes for large business jets and the Bell 429 Helicopter Program. We do not anticipate significant further sequential declines in customer funding from recent levels.

Segment earnings for this most recent quarter were a loss of $5 million, compared with earnings of $2 million, or 2.6% of segment net sales in the first quarter of 2010. Earnings were negatively impacted by reduced sales volumes, including a $5.3 million decline in customer funding, a $2.2 million charge related to a change in the estimate of future workmen's compensation costs, costs related to operating performance and new product launches, as well as the margin impacts associated with the decline in military revenue. Segment earnings included non-cash amortization of $7 million associated with the Airframe Systems acquisitions.

We anticipate that Airframe's earnings performance will improve in coming quarters for the following reasons.

First, we anticipate that our level of after market sales will increase as a result of improved parts availability, operational performance, and rising demand. We also anticipate weapons systems such as the JDAM Guided Tactical Weapon and commercial aircraft such as the Bell 429 helicopter, will improve along with large business jets.

Second, we continue to face supply chain issues affecting parts availability and costs associated with certain production problems, giving rise to incremental warranty costs and overtime. We expect operational improvements to begin to address these issues.

Third, new product launches that are still on early learning curve margins will drive future sales growth and improved margins, as experience and volumes improve.

And fourth, we do not anticipate ongoing workmen's compensation expense to continue at the level experienced this quarter.

Now, turning to Electrical Power Systems. Electrical Power Systems segment net sales for the first quarter of fiscal 2011, which include inner segment sales, were $62 million compared to $57 million for the first quarter a year ago. Deliveries of wind converters led the increase, and were partially offset by declines in power station project deliveries, which tend to vary quarter to quarter, and currency translation. Segment earnings for this quarter were $5 million compared to $7 million for the same quarter last year. Segment earnings as a percent of segment net sales were 8% this quarter compared to 12.9% in the same quarter for the prior year. Segment earnings were favorably impacted by the effective increased sales volumes, but were more than offset by costs related to production capacity increases and higher levels of research and development associated with growth opportunities.

Moving to our Engine Systems results, Engine Systems segment net sales for the first quarter of fiscal 2011, which include inner segment sales, were $92 million compared to $68 million for last year's first quarter, an increase of 36%. We saw very broad improvement in sales related to both large and small engine products. Segment earnings for this quarter increased to $8 million from $3 million for the same period a year ago. Segment earnings as a percent of segment net sales were 8.8% this quarter, compared to 4.8% in the same quarter last year. Segment earnings improved due to the increased volumes.

Research and development costs increased in this segment as well, anticipating continuing growth. Non-segment expenses for this quarter were $7 million compared to $5 million for the same quarter last year. Non-segment expenses were 1.8% of external sales for the first quarter of 2011, compared to 1.6% in the prior year quarter. The increase resulted primarily from larger eliminations of inner segment profits.

Now I would like to focus on certain specific elements of our consolidated financial statements. Gross margin, defined as net sales less cost of goods sold, decreased as a percent of sales to 28.5% in the first quarter of 2011, compared to 29.4% for the first quarter of 2010. Selling, general, and administrative expenses were $33 million, or 8.9% of net sales this quarter, compared to $33 million, or 9.7% of net sales in the same period of 2010. Research and development costs were $24 million for the first quarter of 2011 compared to $18 million for the first quarter of 2010.

As a percentage of net sales, research and development was 6.5% in the first quarter of 2011, compared to 5.4% in the first quarter of 2010. The increase relates to our pursuit and successful capture of new platforms and market share gains. Total depreciation and amortization expense for the first quarter of 2011 was $19 million, consistent with the prior year quarter.

Our effective tax rate for the quarter ending December 31, 2010 was 28.8%, compared to 28.7% for the same quarter last year. Both quarters benefited from specific items, and we still expect our effective tax rate for the full fiscal year to be approximately 31%, reflecting the recently passed US tax legislation, including the extension of the research credit. Capital expenditures were $10 million for the first quarter of 2011, compared to $9 million for the first quarter of 2010.

As previously announced, we are constructing a new systems test facility for our Turbine Segment. Construction will continue through much of 2011. We expect full fiscal year 2011 capital expenditures to be approximately $65 million.

Looking at cash on the balance sheet, Woodward generated $7 million of cash flow from operations for the first quarter of 2011, and a negative $3 million of free cash flow. Cash flow should improve significantly over the balance of the year, and we estimate that free cash flow will approximate $140 million for the year. Our total debt was $431 million at December 31, 2010, compared to $466 million at September 30, 2010. The ratio of debt to debt plus equity was 34.5% at the end of the first quarter, compared to 36.7% at September 30, 2010.

During the quarter, we repaid $13 million of long-term debt and reduced short-term borrowings by $22 million. Our total debt was 1.7 times EBITDA at December 31, 2010, down from 1.8 times at September 30, 2010. During this quarter, approximately 208,000 shares were repurchased in the open market for $7 million. Our cash balance declined from $106 million at September 30 to $61 million at December 31, 2010, reflecting debt repayments, share repurchases, dividends, and negative free cash flow. Working capital, defined as current asset plus current liabilities, was $475 million at December 31, 2010, and $457 million at September 30, 2010.

Lastly, let me turn to our outlook. We expect our markets to continue to improve as the year progresses, and we anticipate further share gains. These views are consistent with those we held when we provided an outlook in November. Therefore, we continue to expect fiscal 2011 sales to be between $1.55 billion and $1.65 billion, and fully diluted earnings per share to be between $1.75 and $1.90 per share. This outlook continues to reflect an expected increase in variable compensation from 2010 to 2011 of approximately $0.25 per share at planned levels of performance.

That concludes our comments on our business and results for the first quarter of fiscal 2011. Operator, we are now ready to open the call to questions.

Thank you. (Operator Instructions)Our first question comes from Tyler Hojo of Sidoti & Company. Your line is open.

Good evening, guys. How are you?

Good, how are you, Tyler?

Good, thanks. So I just want to go back to Airframe for a second. I get, what you laid out in terms of why you think that kind of we've seen the bottom. But I guess maybe what would be helpful, how much of the segment revenues stem from Business Jet? And then maybe if you could also just comment on how the business is performing relative to when you made the acquisitions, and I'm kind of asking that question as it relates to potential impairments here as we move forward.

Sure. Let me address the last point first. We had a significant premium over the book value at the last time we did our formal annual impairment testing. None of the issues that we're currently seeing, we believe, are in any way long-term in nature, and we do believe that the long-term prognosis for the business is just as exciting, if not more so than at the time of the acquisition. So it does not have any significant impact on any potential impairment charge.

From the standpoint of the impact of Biz Jet, it is significant, And, hold on one second here. Roughly 5% to 10% of the total, depending upon the quarter. That is significantly down from original levels, so almost the vast majority, so 60% of the business is military. That has remained relatively stable. So in that remaining 40%, the decrease relative to Biz Jet is what's having so much of the top line impact.

Okay, all right.

Also, I would say, one that we've highlighted s a significant reduction in R&D funding, from customer R&D funding. And the time when we acquired the business, if you looked at the run rate at that time on sales, we're running below that by quite a bit and we're seeing as we move towards second half of this year, we're starting to recover towards those levels where we size the business. We're starting to return to where we think the sales should be, and we're addressing some of the other operational issues as we go.

Clearly, a lot of the things that we called out are related in some respects to integration issues as you go forward in terms of changing your processes and procedures. Some of our parts issues are related to some of that. And so these are not, when we say parts availability and so on, it's a combination of external and internal.

So there have been a fair number of bumps that we've been we've been kind of calling out. We did have some specific quality issues that gave rise to some warranty costs related to some of these changes that I called out. So we do believe that these issues are all addressable and are being addressed, and that we believe we're at the bottom of the cycle at the moment.

Okay, and maybe just as this relates to the guidance range, does your ability to kind of improve the profitability within that segment, is that really kind of the key swing factor between the low and the high end of the guidance? Or help us think about that a little bit.

Yes, we are much more confident today in terms of our ability going forward with respect to Airframe. So I would say our level of uncertainty, while it's still there, no doubt about it, is improved. And, yes, I would say the majority of the range is probably related to the remaining uncertainty with respect to that business.

Okay, that sounds good. And then just one more question for me. I thought in the prepared remarks, you mentioned that you expected Windenberger sales to be up 30% this year. That's better than where you've previously thought it would be, isn't that right?

No, we were anticipating significant sales increases this year, and I think we gave a range on it, but even with what's going on in the market, I think maybe you might be remembering a little bit, Tyler, was the entire Electrical Power Systems segment.

Oh, up 20?

Yes, and that was the entire segment, of which Wind will be up 30.

Okay, understood. And just as - - GE continues to see a lot of pricing pressure. I know you don't do business directly with them, but just if we can think about the profitability of that business, because it seemed like Electrical Power, you know, the margins came in a bit lower than at least what I had anticipated, how do we think about that pricing pressure in your guys' ability to gain market share and still get back to kind of historical profitability levels?

A little bit on our strategy in the Wind market, I think we have shared before, we think with the share gains we've captured, especially during the downturn and going forward, that looking forward we'll be the largest independent producer of wind turbine converters, and we're still looking at other opportunities in front of us. We're using that sales level to drive our supply chain, and really our strategy is compete aggressively in the market, but hold our margins. So there is price, but we expect to be holding the margins.

This quarter, I think Bob hit it a little bit, but this quarter, we ramped up facilities in the US and China, as well as in the existing facilities in Germany and Poland. Poland actually came fully online. And then we also have ramped up our R&D spending. And the sales are coming, so they are just - - the US and the China facility are not operating at an efficient level, but the orders are coming in. I should say we have the orders. They are going to start moving forward, so we expect to get back to the profitability that we highlighted earlier for the segment.

All right, great. Really appreciate it.

Okay, thanks Tyler.

Our next question comes from Fred Buonocore from CJS Securities. Your line is open.

Yes, good evening.

Good evening, Fred.

I'm just following up on your discussion with Tyler on the Electrical Power Systems margins. So, as you're ramping those facilities and you're not quite at efficiency levels, is that sort of volume related, where you just don't have the amount of orders and the volume to help you ramp up that efficiency? Or are you running into any sort of unanticipated issues of note, or a combination of both?

I think the biggest part of it is we've hired staff, we've been doing training, we've been buying equipment. Some of that is expense, some capital. We're getting ready for the volume.

So, we have to get ahead of the curve, and so I would say it's somewhat to be expected. We have seen little bits of movement on some orders, not what I would call in the fiscal year, just moving out of the first quarter, second quarter. So we're comfortable and confident in the sales level and then also in getting this business into the earnings that we had highlighted last phone call. So the orders that we announced, like the Repower order for Hydro-Quebec, those orders are coming in and we're going to start production in the second quarter. It's starting to come, starting to ramp up, and we fully expect the margins to be more what we expect in the low double digits.

That sounds good. And then also referring back to the last call, I think you had indicated that Wind Converters were somewhere in the vicinity of half, if not more of that segment revenues. Is that still kind of a good mark to look at, or is it moving towards higher than that?

Yes, it's a little over 55, 60%, right around there, of the segment.

Okay.So enough to, with that kind of movement, to really meaningfully move margin one way or the other as it goes up and down.

Exactly.

Okay, and then just referring to something you talk about in your release on Airframe, just some military programs that maybe had shown some softening, is this really just kind of a typical military timing of orders sort of thing, or budget-related issues?

No, not budget-related. Normal, a lot of them going kind of tranches, and in the first quarter, for example, in particularly on the JDAM, it was a down quarter on JDAM, that will ramp significantly as the year progresses. So quarterly variability, nothing budget related.

Okay, thanks very much.

Sure.

Our next question is from Peter Lisnic of Robert W. Baird. Your line is open.

Good afternoon, gentlemen.

Good afternoon.

I guess first question, just to help kind of call out these numbers a little bit, can you help give us a little feel for the $5.4 million of R&D, kind of how that's allocated among the segments?

It's largely across the board. Slightly larger in our Turbine business, but every one of our businesses saw increases in R&D. So it's fairly well peanut-buttered.

Okay.

Also maybe just a little extra color, is that we expect to continue to see that type of year-over-year increase. We called out earlier R&D will be up this year, and so it is going to continue to be an increase, mainly due to all the programs that we've won over the last two years.

Okay, and reasonable to expect it's going to be the same way across the businesses as we progress?

It, as I mentioned, Turbine might have been a little bit higher and that pattern would probably continue.

Okay, all right. Fair enough. And then if we look at Airframe, I think last quarter you were talking about that business maybe being up mid single digits, I think 6% to 8% was sort of the commentary top line. But this first quarter looked a little weaker than I had expected. Still, should we still think about that 6% to 8% as sort of the growth target for the business as you kind of progress through this year?

It's close to that for the year. So, yes, we have not significantly changed the overall top line growth target for the year, and so it will be close to that, yes.

Okay, all right. Fair enough. And then on EPS, I guess I didn't catch this really, but the pricing dynamics, understood that you're obviously spending on new programs and initiatives to gain some market share, but I guess if there's a way to look at it on a like for like business or what your competitors are doing, can you maybe give a little bit of color commentary what's happening to the pricing environment from that perspective?

Yes,, I think as Tom mentioned, we are seeing pricing pressures like everyone else is in our strategy to counter those, so as the industry consolidated, as the industry matured, we anticipated that we would see pricing pressure. And about the only way you can really counter that, obviously labor productivity is something you work on. The other is, if you can gain share and drive up your overall volumes, then you can see some economies of scale related to that, that will allow you to counteract some of the pricing pressures.

So that has been our strategy to gain share. We've announced some fairly significant gains with our major customers, and so we believe that that strategy is holding for us so far. But we don't mean to imply we're not seeing pricing pressures, just that so far we've been successful in counteracting them.

I was just wondering what the order of magnitude might be on those pressures. You were talking about the low single digits, mid double digits. Ball park?

Pete, a little bit I would highlight that the price, part of what we planned on the Wind business, and I always equate it that, over time, it's going to look like the Gas Turbine business. What I meant by that is when we entered it, it was an immature market, lots of players, and if you look what's happened since we entered, the big power players, so you've got GE bought in, Siemens bought in, you've got UTC now entering, you've got Allston in there. They are consolidating.

And what we did is started to use the same approach we've used in our Gas Turbine market. We started working with them on a global basis, putting together long-term agreements that run three or more years, that allow us to use, leverage on the supply chain, to use new design concepts, platforms to get our costs down, so that we can offer up savings; as this industry goes into maturity, it's going down a cost curve. We're trying to help our customers get there, but get ahead of that with cost reductions from both supply chain and design to hold margins. And that's what we believe we can do.

So that's been integral to our strategy as this industry matures, and I think we're being successful with it right now. The margins in the quarter weren't down really due to pricing. I really think that they were more down due to the costs we added, both in R&D and operational, in anticipation of the growth coming. And like I said, we've got a little bit of movement of some sales from first quarter to second quarter, but we still see this 30% for the year-over-year improvement, and we had to get ready for that. So that drove up some expense.

Okay. Understood. Good explanation there. And then last question, if I could, just ignoring fiscal 2011, maybe give us sort of the anecdote about what your customers are telling you on the longer cycled power spending side of the equation, more bullish, less bullish, what the outlook is there is ignoring 2011, but more longer term.

Yes, it's extremely bullish, actually.The demand for power and the amount of power plants even being forecast in the US and around the world is quite high. To meet the demand really over the next decade is going to require a lot of gas turbines. The reason I say that is there's a real pressure on coal plants, as you know. You can't get nukes up fast enough, and the renewables can't meet the demand in this timeframe.

So gas turbines, we think are going to be very strong, and we think if you take that from today, for the next 10 years, we think it's going to have some very strong growth. We've been doing very well in there, expanding our content per machine and expanding some of our customers. So we feel real good about the long-term outlook in that industry.

Okay, alright. That is very helpful. Thank you for your time.

Thanks, Peter.

Our next question comes from Greg McKinley of Doherty. Your line is open.

Thank you. You mentioned the upcoming supplier selections for the A-320 to occur over the next two quarters or so. Can you sort of outline for us what are the risks and opportunities for Woodward in that process, and what is sort of the spectrum of potential outcomes?

Sure. The two engine manufacturers that have been selected are Pratt and Whitney and CFM, the GE Snecma consortium. We're working with both companies. They are definitely looking at sourcing more towards the system level than a component level. That's going to drive the opportunity for significantly more content than we have on the current CFM, or on the B-2500 engine.

So this is something that we've highlighted.We've actually been working on these programs for six years in anticipation that this next generation of turbines is going to come out. We've put a lot of investment and a lot of work in this, and we are aggressively going at it. We think we're pretty well positioned to see a sizable content increase, but we won't know until we secure the programs., and they are right now under competitive bid in the marketplace.

So we feel well positioned. The opportunity is for sizable growth, and I guess if you're asking the range, the down side is that if we lose the programs, it would be significant sales reductions as were on the current A-320, and that would impact the business quite harshly as well.

Any school of thought on Boeing's likely response over time?

We believe Boeing will definitely come out with a competitor. Whether it's a reengine or new, they are still debating that. What I can tell you, though, in the timeframe that Boeing will come out, the only two engine choices are going to be the Pratt and the CFM.

Oh, okay.

Okay. So if you secure these programs, you will be positioned for the 737 upgrade or replacement. And I want to also make sure everyone knows that the CFM engine and the Pratt engine have already been selected for C-series, the Russian commercial airliner, as well as the -Komak 919 in China. What you'll see is these two engines will appear across all these new narrow body offerings, and so very, very important programs for our Company.

Great, and then, Bob, I apologize if you already gave some color on it, but can you just refresh my memory on R&D expense, obviously some accelerated reinvestment there. How do you expect that to behave as the year progresses?

We will continue at these elevated levels, if not slightly higher as we go in terms of dollars, and the percentage will moderate slightly, only because the sales growth will be slightly larger than that dollar growth in the R&D.

Thank you.

You're most welcome.

Our next question comes from Unidentified Participant of Fiduciary.Your line is open.

Hi. Could you please address maybe the lessons learned from the MPC acquisition? And just any things to have to do with future M&A and capital allocation, how you might look at the differently, given the experiences you've had with MPC in terms of integration and then also with your ability to forecast sales in those businesses?

When we spoke maybe 12 months ago, there was a fair amount of certainty that that deal was going to turn out to be a pretty attractive deal on an economic basis, and it's a sizeable amount of invested capital at $350 million roughly, and a year later, it's by my math, running at $20 million to $25 million in sales and a couple million in losses versus $30 million to $35 million a year ago. Thanks.

On the question I guess what I would look at is first with both the MPC and HRT acquisitions, these are businesses that we felt were long-term positive fits with the Company and they became available during the recession, as you remember. And we thought we did a good job of modeling the range of sales, if you want to say sales decline that was going to come from the recession and the like. We might have missed a little bit on the downsize. So the sales are below where we had anticipated, but not wildly out of the range.

We look at it a lot of ways in this business, and the products that are in it, kind of like our Aerospace side of our Turbine business, that you've got 20-year to 40-year lives on the products that we think it was worth, and still are pleased with the businesses that we purchased them in the downturn. On a cash basis, they are paying for themselves, which, I don't know if everybody recognizes that, that they are paying for themselves on a cash basis.

We have pushed aggressively, on some of the integration and upgrading business, the IT business system, bringing the two together. It was a requirement on our part to really get that, to comply with government contracting, so that has caused some operational disruptions. I mean, it's a lesson learned. I'm trying to draw a lesson learned out of that, except maybe we should have planned for some disruption due to the implementation and synchronization of the business systems.

We're starting to see the sales recover. We size, when we acquired the two businesses and we went into the downturn, we sized the businesses approaching just under $400 million of sales, which was below the run rate when we acquired them, so that was the sizing we did. We are right now operating below that level, but by the end of the year, we'll be approaching that level and starting to hit the earnings number.

So one of the issues there, and again, I would say this is I don't think we changed this either, is the only way to have really pulled costs down further was to have really hit engineering and the R&D, and due to the amount of programs and the wins we had, we didn't think that for the long-term health of the Company or the long-term prospects that that would have been the right thing to do. It's kind of a conscious effort to keep investing in the new programs versus cutting them, as the sales went down.

So a lot of these factors coming through, we have had some, as Bob will highlight some operational issues, which we probably with maybe more aggressive staffing in terms of the operations area, we might have been able to stem some of those. That's a lesson learned we could apply going forward, is to make sure we're a little more careful on that. But overall, we're not pleased with the financial quarterly result, but we are pleased with the two businesses, the opportunities that are ahead of them, and the way they are coming together. So, as we look forward in the fiscal year and into next year, we see this moving into good profitability and ongoing strength. So, a little long winded there, but hopefully that answers some of the questions you had.

Yes, thank you. Could you maybe just briefly comment on part of that, the rationale for those deals was the growth in the aftermarket? Can you maybe just comment on the progress there, please? Thank you.

Yes, right now, when we acquired the two businesses, their aftermarket as a percent of sales was below 20%. We believe that, and I'll use this term, we believe the entitlement of these businesses in the Aerospace industry for aftermarket should be closer to 30% to 35%, okay. And the issue we had there, and we are gaining some progress on it, was one, to focus on the aftermarket. Two was how we were doing parts, planning availability, and the third one was operational performance on how quickly we could turn repair and overhaul.

We were not, when we acquired the companies, real strong in parts management or in turn times on repairs. Both those have improved substantially. We're seeing the aftermarket order book improve, and our operational performance has been improving, and so as we go through the rest of this year and into next year, I think the after market will continue to grow, but it will take a number of years to get up to that 30% to 35%, which is where we believe it can achieve, and with that is good margin improvement.

One thing I think you mentioned early on that I wanted to catch was, I think you thought the MPC sales per quarter were about $20 million. They are actually almost close to double that, so just to get you a bearing on that. They are not as depressed as you would potentially describe them.

Okay. Thanks. And then you had suggested that they are earning their way on a cash basis. I'm a little confused by that. I guess when I look at HRT, maybe I could see how that's earning its cost of capital when I do some rough math. But MPC, I struggle with that one.

One thing I would maybe clarify my comment, is we're kind of merging these two. We don't operate them as separate entities anymore. And so operationally, they are together. Management teams together, supply chain teams are together. So when I'm talking about that is the combined of the two entities.

Okay. Thanks.

(Operator Instructions) Our next question is from William Bremer of Maxim Group.

Hi, gentlemen. Can you hear me?

Yes, Bill.

Good evening.

Good evening.

Let's go into the Electrical Power Systems. Can you give us an idea of what proportion of your inverters are onshore versus offshore at this point?

Today I would say the majority of all turbines are onshore. But we are the supplier for a couple of our customers for their offshore machines. Now, Offshore's just starting to ramp up, so we expect more sales there. But we are certified on the offshore machines.

Okay. Are any of your offshore machines installed in the European?

Yes, not too long ago, last six months or so, maybe longer, we announced in particular North Sea project that we were a part of. So, yes, we do have European offshore presence.

Okay, and are there aftermarket opportunities there? And how should we look at that?

Yes, that's a good question in that it's a growing opportunity. In terms of for the wind converters in the aftermarket, we really have several revenue streams. We do field service for some of our customers, and we also have part sales, and we also have repair and overhaul, because power inverters do wear out. So there is, we think, a growing after market potential here and we've been putting some real focus and strategies together on how to capture more as machines gain hours in the field and that opportunity starts to materialize.

Can you touch base a little bit on the grid controls? This has been a hot area in the field with a number of players. Can you give us an idea of how you are performing there, and how's the pricing in that environment?

Yes, the, the controls, what we always refer to as the grid controls, the market is increasing. There's a lot of investment, we believe, coming in that area. We are not really seeing pricing pressure. It's actually some good margin products, because basically we're just doing controls, which has good margins there.

And as you're starting to see more and more distributive power put in, as you see more sophisticated communication, we're not the ones doing the main, if you want to say the main skein of systems, but we're the ones that take the action from those or provide the input in terms of signals and what's going on with the grid. So we should see continuing growth there, both on new installs, but also on retrofitting. What we call our Power Protection Distribution products, are up about 12%, so we're seeing growth on the sales side, good margins. So those are good.

Long-term outlook, the idea of the upgrades to the grid is a long-term play, and we feel we're well positioned to start growing with that.

All right, Tom, thank you. I appreciate it.

Our next question comes from Gary Farber of CL King. Your line is open.

Okay, thank you. Just one question on the Engine business. Were there any particular end markets that were unusually strong in the quarter?

It's really refreshing, I have to say on the Engine market, for our portfolio, it would have been across the board. And we're seeing strong power Gen. We're seeing mining coming back. As you all recall, we do a lot of work in compressed natural gas, both vehicles, as well as stationery. Those are increasing.

And really the outlook from the big players and some of our big customers is very positive. So as you might recall from past discussions, the Engine business is one of our faster cycle businesses and we usually say the Small Engine is the fastest cycle we have. That kicked up early. Now the Large is right behind it, and it's moving ahead really quite nicely.

As Tom mentioned earlier, with respect to natural gas, the large gas picked up pretty good in terms of it across the board, but notable in that area.

Is there any difference as far as geography in the US versus overseas where you are seeing the increase in demand?

Oh, for sure.We're not seeing a lot in the US. It's mostly Middle East and Asia.

Okay, and Europe?

Not huge there. But as Bob said, it's mainly, Middle East, Asia, India.

Emerging markets.

Yes, the emerging markets. One that we were pleasantly surprise, not surprised, but pleasantly seeing, is that the longest cycle, which for us in the Engine world is the Marine market, and even that's turning up. So that was probably what we would say was the last [lagger], and it started to turn up this quarter.

Okay, thanks.

Our next question comes from Fred Buonocore of CJS Securities.

Yes, just a follow-up on the Turbine side. Can you talk about how much commercial aftermarket was up within Turbine on a year-over-year basis, and was it also up sequentially?

Commercial aftermarket was up, and yes, I believe it was also up sequentially. So it was definitely up year-over-year, and up sequentially as well.

Are you seeing kind of in line with revenue passenger miles, or more or less of the snapback in your business?

If you recall, we kind of called out - - the fleet dynamics really were in our favor throughout the downturn. So we had not seen the vertical line up, because A-320s were still flying and that's where we had a lot of content, and we didn't have as much content in some of the aircraft that were being parked. So, it is in line with miles and the indicators, but not as dramatic in terms of our change because of that dynamic.

Sure, because you didn't see as much of a downturn.

Exactly.

And what about on the aftermarket side for the industrial gas turbines? I mean, that's been a strong, strong market for you. Is that continuing?

Yes.It's holding, and we're seeing utilization up, so we still anticipate continued growth in that.

I think we've also talked from time to time, we don't see the aftermarket as directly sometimes, because it goes through other channels that aren't as easily identifiable. So it's less visible to us.

Right, and I guess on the last call, you talked about Turbine margins being closer to the 22% range. I guess we were around 24% this quarter. Should we expect the incremental R&D to continue to notch that down as the quarters progress, or is this a potential source of upside?

I think the R&D will temper it somewhat, and also we've had a favorable mix on aftermarket that's helped a lot, too. We've always called out that that can have quarterly variability.

Okay, thanks very much.

Sure.

Our next question comes from Tyler Hojo of Sidoti & Company. Your line is open.

Hi, just a follow-up to the last question. Why would the mix change in Turbine System if industrial gas turbine shipments are expected to be down in calendar 2011 and service-related sales should probably, just given the installed base, be probably flat to up? I'm just trying to get my mind around that.

Tyler, we don't expect OEM sales to be down. We actually expect them to be up nicely.

For Large Industrial Gas?

For across the range, Large Industrial, Steam, Aero derivatives, and also Small Industrial. So, the picture is improving and we are anticipating sales growth. Now, utilization's improving, too, so that should drive aftermarket.

As Bob said, it comes from some of the aftermarket and the heavy frame market; we see some of it coming from our OEM. It flows through our OEM customers in that industry. So we see it a little differently than we do like on the Aero side where it's a direct sale for the airlines. Right now, the outlook for the remainder of the year is up with nice growth.

Okay, great. And just one clarification, the year on year growth rates that you gave, in terms of the segment sales growth, those all remain intact relative to where they were in the fourth quarter of the year, when you provided - - ?

Yes.

All right, great. Thanks a lot.

Sure.

Mr. Gendron, there are no further questions at this time. I will now turn the conference back to you.

Okay. Well, we appreciate everybody joining us today, and we appreciate your interest in the questions. Look forward to talking to you over the next quarter. Thank you.

Ladies and gentlemen, that concludes our conference call for today. If you would like to listen to a rebroadcast of this conference call, it will be available today at 8.00 PM Eastern daylight time by dialing 1-888-266- 2081 for US calls, or 1-703-925-2533 for non-US calls, And by entering the access code 1492430. A rebroadcast will also be available at the company's website, www.Woodward.com, for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your line.